The IRS has just released a private letter ruling (PLR 202434006) involving a new employee choice design that allows eligible employees to make an annual election before the start of each year to direct employer funds (i.e., the employer contribution) to be dispersed in one of the following ways:
- Contributed to the employee’s defined contribution (DC) plan account as an employer contribution
- Contributed to the employee’s health savings account (HSA), subject to the regular HSA statutory limits ($4,300 for individual coverage and $8,550 for family coverage in 2025)
- Used for the employee’s student loan reimbursements (SLRs) through an educational assistance plan, subject to an annual limit of $5,250 when combined with other educational assistance
- Contributed to a retiree health reimbursement arrangement (HRA)
Employees would not have the right to receive the employer funds in cash or as any other taxable benefit.
Significance of the PLR
In recent years, employers have been interested in allowing more choice and flexibility in their benefit programs to better meet employees’ diverse financial needs and preferences — particularly with respect to student loan debt and unexpected medical expenses — but the legal, compliance, tax and administrative challenges associated with employee choice programs have been difficult to overcome.
The IRS’s approval of this new flexible choice design, which empowers employees to decide how to invest the employer contribution between saving for retirement, paying down student loans or saving for healthcare expenses, is a significant step forward.
Note that a PLR can only be relied on by the taxpayer that requested it. Employers interested in pursuing a similar choice program should consider seeking their own PLR.
IRS rulings
With respect to the DC plan, the IRS ruled that because employees were not permitted to receive cash or a taxable benefit, the amounts elected by an employee to go into the DC plan would not be treated as elective deferrals, i.e., the choice would not be a “cash or deferred election” and would not be subject to the Internal Revenue Code (IRC) section 402(g) limit.
With respect to the retiree HRA, the IRS ruled that because employees were not permitted to receive cash or a taxable benefit and the employer contribution is not made pursuant to a salary reduction election (as required under HRA rules), and because the other requirements that apply to HRAs are satisfied, the choice program would not affect the treatment of contributions to and payments made from the retiree HRA for qualified medical expenses as amounts excludable from the gross income.
With respect to the HSA, the IRS ruled allocation of the employer contribution to an employee's HSA is excludable from the gross income of the employee, provided that 1) only HSA-eligible employees may elect to allocate the employer contribution to an HSA and 2) the applicable HSA contribution limits are not exceeded.
With respect to the educational assistance program, the IRS ruled that because employees do not have a choice between educational assistance and other remuneration includible in the employee’s gross income (which is a requirement under IRC section 127), the choice program will not affect the tax-free treatment of payments made under the educational assistance program. The IRS also ruled that an employee’s ability to allocate the employer contribution between different benefit programs would not prevent the educational assistance program from qualifying under IRC section 127.
Note that nontaxable SLRs under IRC section 127 are currently available only through 2025, unless extended by Congress. A bipartisan, bicameral bill to extend the tax-free student loan repayment benefit permanently under IRC section 127 was recently introduced. Although we don’t expect to see the bill move forward this year, its introduction shows that the issue is on Congress’ radar and helps set the stage for the issue to be included in next year’s tax discussions.
Considerations for employers
- Cost considerations. The employer contribution was “paid for” by utilizing a portion of an existing DC plan discretionary contribution. As a result, the program can be cost neutral in many cases, especially if the employer has an existing non-matching contribution design component to leverage, outside of administrative and implementation costs.
- Effect on nondiscrimination testing. Allowing employees to choose where employer dollars can be allocated will lead to non-uniform employer contributions to the DC plan, HSA, retiree HRA and educational assistance plan. As a result, it will generally be helpful to model the effect of the choice program on nondiscrimination testing results for the various programs based on the employer’s specific employee demographics, plan provisions, existing elections and expected participant choice behavior under alternative design scenarios so that any potential testing issues can be identified and addressed in advance.
- Need for robust communication. Important differences will likely exist between the various options depending on the employer’s design. For example, there may be differences in vesting, the ability to self-direct investments, portability and other factors. Employers might consider modifications that make the program options more comparable (e.g., eliminating any vesting requirement on the “choice” portion of the DC plan contribution so that it is comparable with the HSA and SLR options). The differences that remain should be clearly communicated to employees before the election. It is also advisable for employers to provide sufficient information, potentially including tools and resources, to enable employees to choose the option that best meets their personal situation. There will likely be other messages the employer wishes to provide (e.g., linkages to the employer’s total rewards program).
- Administrative considerations. Allowing employees to choose where the employer contribution will be used will add some complexity to plan administration. For example, the election will require coordination across multiple vendors. Also, employers will want to take steps to avoid an employee making excess contributions to his or her HSA (limit is $4,300 for individual coverage and $8,550 for family coverage, for 2025) or exceeding the educational assistance plan annual limit ($5,250, which includes SLRs and employer tuition reimbursement payments) as a result of the choice program. The employer in the PLR included safeguards — i.e., employees who elect to have the employer contribution go into the HSA are not eligible to make pre-tax payroll contributions to the HSA until after March 15, when the choice contribution is funded. Similarly, employees who elect to have the employer contribution used for SLRs are not eligible to receive other benefits from the educational assistance program until after March 15.
